What Is Adjustment in Conversion Terms?
In finance, an adjustment in conversion terms refers to a change in the conversion price of a security, which is made to reflect the change in the security's value, such as after a stock split. The adjustment in conversion terms can either be scheduled or depend on any related changes so that the holder of the convertible security remains unaffected. To adjust the conversion price, an Officer's Certificate is used to delineate the facts on which such conversion price adjustment is based.
Basics
In finance, adjustment in conversion terms entails altering the conversion price to mirror fluctuations in a security's value, which may occur following events like a stock split.
Adjustment in Conversion Terms in Practice
This term applies to convertible securities where changes in the conversion factor are necessitated due to splits in the underlying exchangeable stock. In some convertible cases, these adjustments follow a predetermined schedule. Otherwise, these adjustments are made in order to ensure that the holder of the convertible remains unaffected by any related changes.
For instance, let's consider a scenario involving Company ABC's convertible security, with a conversion privilege of one common stock share for $50. If ABC's common shares undergo a 2-for-1 split, the exchange ratio will be recalibrated to one common share for $25.
Numerous events trigger adjustments in the conversion price of a security, encompassing stock dividend disbursements, stock splits, stock re-classifications, or any combination thereof. When such an adjustment is deemed necessary, the company must meticulously compute the adjusted conversion price, adhering to the specifications outlined in the An Officer's Certificate is a document that a high-level executive of a company signs. It serves as an official record of the executive's affirmation or certification of certain facts or information related to the company. This authority may rest with individuals like the board chair, president, chief financial officer, chief executive officer, controller, principal accounting officer, treasurer, or general counsel. The Officer's Certificate meticulously delineates the factual basis underpinning the conversion price adjustment. After a conversion rate alteration, the issuing company usually dispatches a notice detailing the new price to shareholders through first-class mail.
The conversion ratio remains susceptible to alterations. Every time new shares are issued, existing shareholders find themselves at risk of dilution, as the overall share count expands due to the addition of preferred or common shares. To mitigate this dilution, anti-dilution protections are often implemented, which serve to recalibrate the conversion ratio and counteract the dilution stemming from new issuances.
Optional vs. Mandatory Conversions
Optional Conversion
Shareholders are allowed to convert their preferred shares into common shares when they anticipate greater returns from converted common shares, primarily driven by a combination of a modest liquidation preference multiple and limitations on shareholder participation rights.
Mandatory Conversion
In stark contrast, mandatory conversion rights obligate preferred stockholders to automatically convert their shares into common stock, often referred to as "automatic conversion."
Conclusion
Adjustment in conversion terms is a key financial mechanism for adapting conversion prices, essential after events like stock splits. These adjustments, whether planned or reactive, aim to protect convertible security holders, documented through the Officer's Certificate. Practically, conversion term adjustments help maintain the integrity of convertible securities with careful calculation and transparent communication, reducing the risk of dilution.
Furthermore, optional and mandatory conversions highlight the choice and obligation in conversion decisions. Shareholders can opt for favorable conversions, while mandatory conversions align with company policies, illustrating the flexibility and adaptability of financial instruments in response to market dynamics.